Getting Bullish on Bank ETFs

The Financial Select Sector SPDR (NYSEArca: XLF), the largest exchange traded fund offering exposure to the financial services sector, is up 8.4% since the start of the fourth quarter.

That puts XLF in a tie with the Utilities Select Sector SPDR (NYSEArca: XLU) for the fourth spot among the nine sector SPDR ETFs in the current quarter, but that should not be interpreted as a sign that XLF and rival financial services ETFs are laggards. With the sector’s momentum and earnings expectations rising,

Last week, S&P Capital IQ’s Investment Policy Committee (IPC) upgraded the investment outlook for the S&P 500 financials sector to marketweight from underweight. Sam Stovall, Equity Strategist for S&P Capital IQ and chair of the IPC cited the sector’s “reasonable valuations, the benefits from an expected improvement in U.S. economic growth and labor markets, plus what we see as a manageable interest rate environment, have enhanced our outlook for the group.” [Calendar Says its Time for Financial Services ETFs]

Expectations of solid earnings from major banks, such as those that line XLF and comparable financial services ETFs, jibe with recent revenue data. Last month, the Federal Deposit Insurance Corporation revealed that U.S. banks posted profits of $38.7 billion in the third quarter, compared to $36.1 billion for the same period last year. [Big Revenue Growth for Bank ETFs]

“The sector’s operating EPS are expected to rise 12.7% in 2015, versus the estimated gain of 8.8% for the S&P 500 based on Capital IQ consensus estimates. In addition, Stovall noted the group’s PEG ratio (2015E P/E to projected five-year growth rate) stands at 1.4X, which is equal to that for the broader market. However, the sector’s relative valuation on trailing EPS is currently at a 20% premium to its 20-year average,” said S&P Capital IQ in a recent research note.